According to the first release, in Q3 GDP increased by 2.6% QoQ annualised, better than expected. However, most of the rebound was due to net export, as consumption and imports slowed down, in line with the worrisome signals sent by household surveys and retail sales. We expect a marked slowdown and a contraction in activity in H1 2023 (top chart), with 2023 average growth at just 0.2%. The past tightening in financial condition is already affecting heavily the construction sector (the 30-year mortgage rate now exceeds 7%, the highest level in 20 years). It will gradually dent consumption, adding to the loss of purchasing power due to persistently high inflation.
September CPI data provided a nasty surprise, with the core rate rising to 6.6%: easing supply gridlocks have driven down inflation to 6.6% after the 11% peak earlier this year, but services inflation continues to trend higher (6.5%, against 4% in January). According to surveys, firms expect a reduction in their pricing power, and a less tight labour market should moderate wage growth. However, growth in the important rent component of the price index is not set to moderate soon, as it adjusts to a three/four quarter lag to changes in house prices, which have just started to abate: in August the yoy growth of the Case Shiller index dropped from 21% to a still high 13%.
After another 75bps hike in November, the Fed should moderate its pace of normalisation, with a 50bps increase in December and a final 25 bps one in Q1 2023; rates will then peak at 4.75%. FOMC members have reiterated the need to bring rates to well above neutral and keep them for long in order to tame inflation, confident that the economy can withstand it.
However, the slowdown of the economy will push unemployment above the 4.4% expected by the FOMC for the end of 2023, forcing the Fed to cut rates in the second half of next year.
